Detailed in-depth notes for the first year 'Financial Management' paper on 'Income Statements'. Mainly based on lectures, with summaries of readings (where applicable), learnings from pre-work problems, and personal explanatory notes included where relevant.
Prepared by a student scoring 88% on th...
FM Lecture 3: Income Statement and Revenue Recognition
Income statement links balance sheets at the beginning and end of the accounting period
through retained earnings account in the owner's equity section of the BS
o Retained earnings (initial) + net income/loss - dividends = retained earnings (final)
o Sales – expenses = net income/ loss
o Note that dividends are separate from net income: not treated as an expense, it is a
distribution of capital
Income: increases in assets (eg. Cash, accounts receivable) or decreases in liabilities (eg.
Unearned revenue) that result in increases in equity, other than those relating to contributions
from holders of equity claims (eg. New share issuance with fundraising)
Expenses: decreases in assets (eg. Inventory) or increases in liabilities (eg. Accounts payable)
that result in decreases in equity, other than those relating to distributions to holders of equity
claims
Matching principle: revenue and expenses that result directly and jointly from the same
transactions or other events should be recognised simultaneously in the same period.
Elements to include (not all needed):
o Revenue: income that arises during the ordinary activities of an entity
o Gains and losses arising from the derecognition of financial assets measured at
amortised cost
o finance costs
o share of the profit or loss of associates and joint ventures accounted for using the equity
method
o If a financial asset is reclassified so that it is measured at fair value, any gain or loss
arising from the difference between the previous carrying amount and its fair value at
the reclassification date
o tax expense
o a single amount for the total of discontinued operations
Expenses can be recognised by nature or function
o Nature: eg. Raw materials, employee benefits, D&A
o Function: eg. Distribution costs, administrative expenses
Other comprehensive income
Other comprehensive income does not affect net profit
Impairment loss is immediately recognised (goes to expenses and affects net profit), but
appreciation of assets would be under other comprehensive income. Conservatism principle.
Not all income/ expenses are recognised in the income statement (not included as revenue/
expense). May be included in 'consolidated statements of comprehensive income' instead:
o Unrealized gains/ losses (eg. marketable securities)
o Revaluation gains and losses
o Remeasurements of defined benefit plans
o FX: gains/ losses arising from translating financial statements of a foreign operation
o For particular liabilities designated as at fair value through profit and loss, the amount of
the change in fair value that is attributable to changes in the liability’s credit risk
o Items relating to hedging instruments
, Other comprehensive income: line items classified by nature and grouped into those that, in
accordance with other IFRSs
o will not be reclassified subsequently to profit or loss
o will be reclassified subsequently to profit or loss when specific conditions are met
Also must disclose:
o profit or loss and comprehensive income attributable to non-controlling interests
o profit or loss and comprehensive income attributable to owners of the parent
Revenue recognition
Revenue recognition is complicated by:
o Bundled goods or services (eg. Phone + servicing service)
o Warranties
o Principal vs agent and consignment agreements (eg. Third party sale of airline ticket.
Note commission only or sales value?)
Example: if supermarkets sell a supplier's flowers and the supplier still bears the
inventory risk if flowers wilt before sale, supermarket cannot record flower sales
as revenue. Only the commission from the sales is recorded as revenue
o Customer options for additional goods or services (eg. Option for future discounts after
a purchase)
IFRS 15: Revenue from Contracts with Customers
Contract identification
o Consideration: a payment made by one party to another in exchange for the transfer of
something of value
o It must be more likely than not that consideration will be collected –it can be variable
o Contracts can be combined as one portfolio provided the accounting will not be
materially different
Identification of performance obligations
o Multiple distinct goods or services: the customer can benefit from each good or service
on its own. Transaction price needs to be allocated to each performance obligation
o If not distinct, they are combined until a bundle of distinct goods and services are
identified
o Single performance obligation: all promised goods and services are highly interrelated
(eg. Construction of building, sale of software and customized integration into a
company's backend)
Satisfaction of performance obligation
o Performance obligations are satisfied when the goods or services are transferred to the
customer
Customer obtains control of goods or services
Risks and rewards of ownership may be an indicator
o Revenue is recognised over time if:
Customer simultaneously receives and consumes the benefits of the company’s
performance (eg. service contract)
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